South tax movement: Reasons why Karnataka is protesting against Union government over fiscal injustice

It isn’t the first time Karnataka or other states like Tamil Nadu have raised concerns over fiscal injustice to progressive states.

This time around, however, the issue snowballed after DK Suresh — a Congress MP and Karnataka Deputy Chief Minister DK Shivakumar’s brother — criticised the reduced allocation of funds to Karnataka in the interim budget.

Suresh’s remarks, that states might be compelled to seek a separate nation if corrective measures weren’t taken to address concerns of fiscal injustice, sparked outrage.

Related: CM says Karnataka lost over ₹45k cr in 4 years due to Centre’s tax devolution

Beyond the outrage over ‘separate country’ rhetoric

Beyond the outrage lies the reality of progressive states being punished despite performing well.

In the case of Karnataka, it isn’t limited to a reduced share of taxes from the Centre’s divisible pool. It is also the Union government’s refusal to honour recommendations of special grants to the state.

Responding in the Lok Sabha on Monday, Nirmala Sitharaman said there was a system in place, and the Union government worked on the recommendations of the Finance Commission.

She, however, as finance minister and a Rajya Sabha member from Karnataka, said nothing about why the recommendations of the same Finance Commission on special grants to Karnataka were not accepted.

The latest outrage stemmed from the interim budget’s estimates on the redistribution of Central duties and taxes — in simple terms, devolution.

Uttar Pradesh alone is estimated to receive ₹2,18,816.84 crore from the Central pool of taxes this fiscal. That is over ₹26,000 crore more than the allocation for all five southern states — Karnataka, Tamil Nadu, Andhra Pradesh, Telangana and Kerala — put together.

This is despite Tamil Nadu and Karnataka being among the five largest contributors to the country’s GDP. This is only one aspect of the concerns around fiscal redistribution.

Also Read: BJP did nothing to get drought relief for Karnataka, says DKS

Why is Karnataka alleging fiscal injustice?

Karnataka has raised three primary concerns to justify its allegation of fiscal injustice by the Union government.

One is the reduced share of 3.64 percent in the 15th Finance Commission. The 15th Finance Commission using 2011 census data to set Terms of Reference (ToRs) instead of the 1971 census meant that states that failed to implement population control measures effectively were already at an unfair advantage over states that performed well.

Had the ToRs of the 14th Finance Commission, which recommended a 4.71 percent share to Karnataka as devolution, been applied by the 15th Finance Commission, the state would have received an additional ₹62,098 crore between the fiscals 2020-2021 and 2025-2026, as per the Karnataka Finance Department estimation.

It is as if Karnataka was punished with lesser allocation for implementing population control measures effectively and maintaining a sound fiscal policy.

Though the 15th Finance Commission recommended that 41 percent of total Centrally pooled taxes should be shared with states, Karnataka alleges that the Union government is estimated to share only 30 percent, further reducing funds.

Moreover, the Union government has not released ₹6,000 crore in special grants to Karnataka despite the 15th Finance Commission’s recommendation.

Related: CM asks BJP to join 7 Feb protest against ‘injustice’ to Karnataka in Delhi

The GST factor

The second reason is the adverse impact on the state’s implementation of the GST regime.

Karnataka Finance Ministry’s estimation of protected GST revenue versus actual GST collection. (SouthFirst)

Karnataka’s Finance Department insists that when GST was introduced as a Centrally-administered tax, the states were assured of a “protected annual growth” of 12 percent or compensation by the Union government to compensate for the difference.

GST essentially reduced the state governments’ venues to raise their taxes, making them dependent on the Union government’s release of the states’ share of GST.

Karnataka Finance Department estimates show a big gap between the protected revenue and the actual collection of GST.

For example, protected GST revenue for fiscal 2017-2018 was estimated to be ₹35,226 crore. The actual GST collection, however, was ₹24,182 crore.

While the gap or shortfall in actual revenue versus estimated protected growth was ₹11,044 crore, GST compensation from the Centre to Karnataka for that fiscal was ₹6,246 crore, as per the Karnataka Finance Department.

Constitutionally guaranteed compensation to states to make up for shortfall due to the GST regime ended in June 2022 despite states insisting on an extension.

From fiscal 2017-2018 to 2023-2024 (budget estimates), Karnataka’s protected GST revenue was estimated to be ₹4,92,296 crore, but actual collection (including estimates for 2023-2024) stands at just ₹3,26,764 crore. The shortfall is estimated to be ₹1,65,532 crore.

Karnataka has, however, received only ₹1,06,258 crore as compensation (including estimates for 2023-2024) from the Union government.

Related: DK Suresh walks back ‘separate country’ after backlash

Cess and surcharges

The final nail in the coffin is cess and surcharges levied by the Centre. Unlike direct or indirect taxes that go into the divisible pool to be shared with states, collections under cess and surcharges go directly to the Union government and aren’t shared with the states.

Karnataka was among the first states to insist that cess collections be moved to a divisible pool of taxes and shared with the states.

Since 2017-2018, the Union government has increasingly raised cess and surcharges, raising huge revenues, but none is being shared with the states.

An estimation from Karnataka’s Revenue Department shows that between fiscal 2017-2018 and 2023-2024 (estimates), the Union government collected a staggering ₹27,66,588 crore in revenue.

In seven years, collections under cess and surcharge increased by 153 percent.

Moreover, the more cess and surcharge are collected, the lesser funds are made available in a divisible pool of taxes meant to be shared with states.

If this cess collection were to be shared with states, Karnataka could have received ₹45,322 crore in the last seven years.

While the Union government insists that cess is returned to states in the form of funding for Centrally-sponsored schemes (CSSes), questions have been raised about the release of funds and terms of sharing.

In Kerala, Health Minister Veena George alleged that the Union government stopped releasing funds for National Health Mission centres after the state refused to use Hindi names.

The Union government withheld ₹7,000 crore to West Bengal meant for paddy procurement under the food security scheme because ration shops didn’t display PM Narendra Modi’s photos.

India is a Union of States and follows a federal structure. Fiscal federalism is a crucial component of maintaining cordial state-Union relations. Well-performing states like Karnataka are protesting against the Union government for devising multiple ways to make states increasingly dependent on it for finances and resources. The lack of fiscal federalism puts the state in a position of compromise.

Karnataka wants to end fiscal injustice so that the 16th Finance Commission is more fair to progressive states.

While contributing towards developing poorly performing States is a collective commitment, the welfare of Uttar Pradesh or Bihar should not mean punishing Karnataka and Tamil Nadu. That is the crux of the matter.